TAX NOTES

Eliminating intangible value reduces real estate taxes Property taxes are one of the largest expense items on any owner's operating statement. Controlling this expense is directly related to the ability to limit assessors to lawful real estate value in arriving at the market basis for taxation. An intelligent program that recognizes the uniqueness of the property tax can lead to significant tax savings and increased profits.

The property tax is the only tax that varies dramatically from state to state. This is due to differences in assessors' policies, state statutes and court decisions. It is also the only tax based on a subjective standard, fair market value, and can therefore be dramatically affected by convincing evidentiary arguments at all levels of appeal.

Identifying and quantifying intangible value, which is inherent in most large commercial and industrial properties, will significantly reduce the impact of recent sale prices on future property taxation. Intangible value has been acknowledged by the courts in the operation of hotels that have been recognized as being operating businesses.

However, in today's complex market, intangible value is clearly recognizable in other property types. An example of this is a regional shopping mall, the value of which is geared largely to the operating agreements with the anchor tenants that produce the customer base for the in-line mall lessees. Also, acquisition prices paid by REITs are directly related to their tax advantaged structure and their availability of capital. That portion of the purchase price paid for a property that is not directly allocable to land and building should not be subject to taxation.

The recent annual Seminar of American Property Tax Counsel (APTC), The National Affiliation of Property Tax Attorneys on Reducing The Real Estate Tax Impact On REIT And Trophy Properties, studied these issues. Participating in the seminar were the attorney members of APTC selected as the preeminent legal counsel in their various cities and states, as well as numerous real estate industry tax representatives from companies and REITs such as Equity, Security Capital, Marriott, Mack-Cali and Rouse.

The program led to the formation of a committee comprised of corporate tax directors, an economist, an investment banker, a representative of NAREIT and APTC attorneys who will track all tax appeals involving issues of intangible value.

One segment of the APTC Seminar was a panel discussion involving Critical Tax Issues From Negotiation To Closing. The panel analyzed such issues as purchase price allocation during due diligence, portfolio acquisitions and OP unit-based purchases under UPREIT structures.

Further discussed at the seminar was the critical difference between investment value and market value. The appraisal of real estate requires a recognition of the differences between these two concepts. Other issues such as avoiding federal tax problems in allocating real estate value, the flexibility of GAAP accounting principles, implicit capitalization rates and net asset value vs. fair market value were debated.

Understanding the difference between net asset value and fair market value is critical to the process. By definition, net asset value includes the enterprise value of a company as a going concern that incorporates value for management, geographical diversification of investments and market share. Every REIT prospectus recognizes this with a provision that the company did not obtain appraisals of the fair market value of the properties and that the public offering price of the shares and the related underlying valuation of the company have been determined primarily by capitalizing estimated cash flow of the company available for distribution, rather than through a property by property valuation based upon historical cost or current market value.

Although a number of APTC success stories were related, everyone in attendance viewed these issues as evolving concepts that ultimately will be decided by the courts of each state. It is clear that those companies that treat real estate taxes and the abilityto control one of their largest expenses as a mere commodity will fail totake advantage of increasing their cash flows through creative advocacy.